Stock Analysis

We Think Walgreens Boots Alliance (NASDAQ:WBA) Is Taking Some Risk With Its Debt

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NasdaqGS:WBA
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Walgreens Boots Alliance, Inc. (NASDAQ:WBA) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Walgreens Boots Alliance

What Is Walgreens Boots Alliance's Debt?

As you can see below, Walgreens Boots Alliance had US$16.2b of debt, at February 2021, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of US$1.03b, its net debt is less, at about US$15.2b.

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NasdaqGS:WBA Debt to Equity History June 11th 2021

How Strong Is Walgreens Boots Alliance's Balance Sheet?

According to the last reported balance sheet, Walgreens Boots Alliance had liabilities of US$31.2b due within 12 months, and liabilities of US$37.7b due beyond 12 months. Offsetting these obligations, it had cash of US$1.03b as well as receivables valued at US$4.88b due within 12 months. So it has liabilities totalling US$63.1b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's massive market capitalization of US$47.8b, we think shareholders really should watch Walgreens Boots Alliance's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Walgreens Boots Alliance's debt is 3.6 times its EBITDA, and its EBIT cover its interest expense 4.8 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Importantly, Walgreens Boots Alliance's EBIT fell a jaw-dropping 39% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Walgreens Boots Alliance can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Walgreens Boots Alliance actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both Walgreens Boots Alliance's level of total liabilities and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Overall, we think it's fair to say that Walgreens Boots Alliance has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Walgreens Boots Alliance (of which 1 is a bit concerning!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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